In-Depth Analysis: Why Equinix Is A Corona-Proof REIT You Must Own

Introduction

Continuing the series of presenting high-quality SWAN stocks to our readers, Equinix has made it to the list because of one of its impeccable features: visibility. In these challenging economic times, many companies have already withdrawn their guidance as the outcome of the Covid-19 pandemic remains uncertain.


There are, however, reliable growth companies out there which are set to capitalize on the post-corona era. They benefit from secular growth trends, meaning they are not forced to turn the tide but can continue to deliver sustainable shareholder value for many years to come. Equinix, one of our largest US holdings, has recently made a couple of reassuring forward-looking statements regarding its business momentum.


While the stock is far from inexpensive (trading at an AFFO multiple of 28 for FY2020), there's a lot to like about this REIT especially for those looking at portfolio overwriting (covered call writing). 5 reasons why Equinix is a generational buying opportunity are listed in this article.


1) Attractive Business Model and Well-Financed Pipeline

Thanks to a smart management team that focuses on spending 2 billion USD on Capex annually and industry-leading P&E yields of 29%, Equinix was capable of delivering another strong set of results. More importantly, the nature of the data center business requires just 3% of total revenues in maintenance Capex in FY2020, indicating most of the funds go to new product development, cooling equipment, efficiency projects and build-out of new phases.

(Source: Author's work based on company data)

(Source: Author's work based on company data)


Whilst revenue growth rates haven't had an uptick over the past years, they remain robust and pave the way for high single-digit AFFO growth. Also, there are several factors that can boost its rental income such as 2- 5% pricing escalators on existing contracts, interconnection and power density. With long-term leases of greater than 18 years, an investment grade rating BBB- and 4 times net debt to LQA adjusted EBITDA, Equinix makes sure it can keep the projects well-financed.

(Source: Equinix investor presentation)


Over the past 5 years, Equinix' blended borrowing rate has dropped from 4.6% to 3.4% and there's still more wiggle room to take it down to the 3.1% by the end of 2023. At the end of Q1, the company had 2.9 billion USD in available liquidity, not to mention the 1.5 billion USD equity offering launched on May 11 of which the net cash proceeds will be utilized to finance a possible new acquisition of data centers.

(Source: Author's work based on company data)


2) 69th Quarter of Consecutive Revenue Growth

Digital transformation, increasing demand for work-from-home applications, the massive cloud opportunity... the importance of technology and internet storage in particular cannot be ignored anymore. Equinix' market-leading platform, unmatched dominance and diversified tenant base resulted in the 69th quarter of consecutive revenue growth based on the latest Q1 numbers.

(Source: Equinix investor presentation)


It has achieved so by identifying and acquiring strategic multi-year growth opportunities. The REIT managed to grow revenues 26% per annum throughout the Great Recession, while other real estate companies were struggling to fund their operations.

(Source: Equinix investor presentation)


The fast-growing interconnections segment with over 370,000 interconnections as of Q1 2020 will be the key driver as collocation retail revenues are expected grow by 6% annually. Up until now, Equinix has delivered its 13th consecutive quarter of adding more interconnections than the rest of the nearest 10 competitors combined.

(Source: Author's work based on company data)


3) Diversified Tenant Base and Strategic Opportunities in Asia-Pacific

Equinix' top 10 customers currently account for 18.4% of total income, whilst the top 50 tenants comprise 38% of total revenues across a variety of industries such as IT (28%) and Networking (24%).


Although Americas, a rather saturated market for Equinix due to the increased number of competitors, still contributes the biggest chunk to the adjusted EBITDA namely 46%, Asia-Pacific is growing at a much faster pace (15% versus 5%). Moreover, this region's EBITDA margin has recently topped the 53% threshold compared to 49% in 2015. No wonder Equinix stepped into a joint venture valued over 1 billion USD with Singapore's sovereign wealth fund at the end of April of this year.

(Source: Author's work based on company data)

(Source: Author's work based on company data)

(Source: Author's work based on company data)


4) Dividend Growth Rate Among The Highest in REITdom

Right now, either cutting or temporarily freezing the dividend payments is a dilemma REITs are struggling with these days. Equinix and other highly reliable REITs such as American Tower are the exception to the rule as their operational cash flow should easily cover the dividend distributions. Please note that in 2015 Equinix paid a special dividend of $10.95 per share.

(Source: Author's work based on company data)


Going forward, dividends are expected to grow in line with the AFFO.


5) Impact From Covid-19 Offset By Packet Acquisition

Regarding the Covid-19 impact on the data center business, Equinix' management estimates that due to delays in project developments there will be a drag of 0.45% on total revenues. I know of few other companies that are little touched by the pandemic. Furthermore, the Packet acquisition is expected to contribute 36 million USD to total revenues, while the expected integration costs amount to 10 million USD. All in all, the company provided a strong guidance for investors as it reaffirmed the AFFO outlook before any changes in foreign currency and integration costs.

(Source: Equinix investor presentation)

(Source: Equinix investor presentation)


Solid Performance In High VIX Environments

Based on the VIX study I conducted (from 2014 - May 2020), buying Equinix in all VIX environments would have generated forward 1-year returns of 23%. Buying the REIT into VIX strength (above 25%) would have produced similar returns, while adding to your Equinix position in low IV circumstances generally doesn't make much sense.

Technical Analysis

Back in 2011, Equinix shares generated a buy signal based on the MACD, Moving Average and Directional Movement Index. In 2013, the stock hit a temporary high, before breaking out at the end of 2014. That's the signal buy-and-hold investors looking to accumulate were waiting for. For new investors, the breakout represented a first buy signal. In 2018, momentum in Equinix shares cooled, meaning we don't add to our positions or initiate one; we hold onto our existing stake.

In early 2019, shares broke out powerfully, leading to new buy signals. That's the way we should interpret the technical charts as buy-and-hold covered call writers.


Right now, Equinix shares are in bullish chart territory so looking for a bullish covered call strike is appropriate, however, I expect some consolidation between $650 and $680.

(Source: Pro Real Time)


Covered Call Writing: Historical Performance

As mentioned in one of our previous articles, Equinix proves to be a good investment vehicle for long-term portfolio overwriting (thus covered call writing on a monthly basis). The question becomes: do we better adjust our strikes based on the share price or do we maintain the strike when a correction occurs? The latter strategy is meant for those looking to not cap their upside during a recovery, as shown below. Over the past decade, Equinix had a monthly implied volatility of, on average, 29%.


1) Defensive Covered Call Writing: Selling 3% In-The-Money Covered Calls on Equinix

Let's compare not rolling down the strikes during a correction (strategy ° 1) with continuously adjusting that strike (strategy ° 2). Does it make sense for us to act aggressively to collect more credit during the downturns or do we better stick to our same strike and wait for the stock to bounce back up again? Please note that due to rounding the numbers up (in 5 to 10 dollar increments), strategy ° 2 does not depict a 100% 3% in-the-money covered call strategy in all circumstances.

(Source: Author's spreadsheet)


Since we're not adjusting the strikes in strategy ° 1, the distance between the share price and the call strike widens during corrections. It's important to note, however, that in normal volatility environments conservative investors should have long-term puts in their portfolio. By doing that, they create a meaningful hedge against corrections/spikes in the VIX. And the best part about it: the premium paid for the long-term puts is financed with regular covered call sales.

(Source: Author's spreadsheet)


In terms of the return, the red line which doesn't adjust the strikes generated returns similar to buy-and-hold investing, while the green line does see smaller drawdowns but faces longer recovery periods to reach new highs. Regarding the annualized returns for each strategy: 22.04% for covered call writing (1), 22.4% for buy-and-hold investing and 17.35% for covered call writing (2). When it comes to the standard deviation of the strategies, the picture looks completely different: 29.7% for buy-and-hold investing, 20.3% for covered call writing (1) and 14.99% for covered call writing (2). Stated differently, the green line has produced the best risk-adjusted returns, but after corrections, it takes more time for the green line to hit new highs.

(Source: Author's spreadsheet)


2) Moderately Bullish Covered Call Write: At-The-Money Covered Call

When opting for a moderately bullish covered call write on Equinix (looking for at-the-money calls), we get the following picture. Again, let me reiterate that the difference between the two strategies: strategy ° 1 does not roll the down the strikes; whereas strategy ° 2 seeks to sell at-the-money calls. Please note that due to rounding the numbers up (in 5 to 10 dollar increments), strategy ° 2 does not depict a 100% at-the-money covered call strategy in all circumstances.

(Source: Author's spreadsheet)


As stated above, strategy ° 1 does not adjust the strikes.

(Source: Author's spreadsheet)


Regarding the annualized returns for each strategy: 23.9% for covered call writing (1), 22.4% for buy-and-hold investing and 21.2% for covered call writing (2). When it comes to the standard deviation of the strategies, the picture looks completely different: 29.7% for buy-and-hold investing, 21.7% for covered call writing (1) and 17.8% for covered call writing (2). Stated differently, the green line has produced a Sharpe Ratio of 1.19; the red line sits at 1.10; the buy-and-hold approach settles near 0.76.

(Source: Author's spreadsheet)


In terms of the drawdowns, strategy ° 1 (which I prefer) has provided a cushion during the corrections over the past decade.

(Source: Author's spreadsheet)


Annual returns for the covered call writing strategies are far more consistent than those of traditional buy-and-hold investing.

(Source: Author's spreadsheet)


3) Bullish Covered Call Write: Out-Of-The-Money Covered Call

When opting for a bullish covered call write on Equinix (looking for 2% out-of-the-money calls), we get the following picture. Again, let me reiterate that the difference between the two strategies: strategy ° 1 does not roll the down the strikes; whereas strategy ° 2 seeks to sell at-the-money calls.Please note that due to rounding the numbers up (in 5 to 10 dollar increments), strategy ° 2 does not depict a 100% 2% out-of-the-money covered call strategy in all circumstances.


Since we're not adjusting the strikes in strategy ° 1, the distance between the share price and the call strike widens during corrections (in this case up to 20+ %). It's important to note, however, that in normal volatility environments conservative investors should have long-term puts in their portfolio. By doing that, they create a meaningful hedge against corrections/spikes in the VIX. And the best part about it: the premium paid for the long-term puts is financed with regular covered call sales.

(Source: Author's spreadsheet)


As stated above, strategy ° 1 does not adjust the strikes, but rolls out and up if Equinix' share price goes up.

(Source: Author's spreadsheet)


Regarding the annualized returns for each strategy: 24.6% for covered call writing (1), 22.4% for buy-and-hold investing and 23.0% for covered call writing (2). When it comes to the standard deviation of the strategies, the picture looks completely different: 29.7% for buy-and-hold investing, 23.6% for covered call writing (1) and 20.0% for covered call writing (2). Stated differently, the green line has produced a Sharpe Ratio of 1.15; the red line sits at 1.04; the buy-and-hold approach settles near 0.76.

(Source: Author's spreadsheet)


Annual returns for the covered call writing strategies are far more consistent than those of traditional buy-and-hold investing.

(Source: Author's spreadsheet)


Conclusion on Covered Call Writing

Covered-call writing on Equinix with or without adjusting the strikes has resulted in lower monthly volatility and thus significantly higher risk-adjusted returns. What's the most optimal strike price for portfolio overwriting on Equinix? I would say somewhere between 0%-2% above the share price. That would lead to a reduction in standard deviation of 22%-25% with 1.07 times the annualized return of the buy-and-hold investor. These results are based on the massive bull market we've seen in Equinix' share price. Going forward, I count on a total annual shareholder return of 10+ % based on 8%-12% AFFO growth and 2% dividend yield. By implementing the portfolio overwriting strategy, we should be able to earn 20%-25% annually with a noticeable reduction in volatility.


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